As we experience a strong year in our business, new clients always have a list of questions to guide our client-tailored task list, and one question that appears on more than half of those lists is this one:

“We’re making a profit, why isn’t our cash flow reflecting that profit?”

It’s truly not rocket science, folks. It just requires some out-of-the-box thinking that is reflected in a standard report that virtually every accounting software package produces automatically, if only people would learn how to read it. In trying to develop a short post for this week I scanned the text in Chapter 6 of my book Finance for Nonfinancial Managers, for ideas. The chapter is 5,000 words long, so simply inserting it here was not an option, despite the fact that it’s really well written (in as much modesty as I could muster). So if you don’t have the book, at least here is a 300 word teaser that might help.

If the net profit on your income statement isn’t the same as the net increase in your bank account – hint: it never is – the reasons are clearly laid out in the Statement of Cash Flow. Think of net cash flow as an “adjusted net income.” Some examples:

• If you sell something but don’t get paid for it in the same month, you loaned money to your customer and that takes cash out of your adjusted net income, because your accrual basis income statement assumes you got paid for whatever you sold.
• Similarly, if you get paid for something you sold two months ago, that means a customer repaid your earlier loan to them, putting cash into your adjusted net income, since your current month income statement shows no record of that sale.
• On the flip side, if you bought something this month from a supplier, and consumed it this month, but won’t pay the supplier until next month, you just borrowed money from your supplier. Your normal income statement shows money out (but you didn’t actually pay for it). The loan from your supplier is cash not disbursed that will be reflected in your adjusted net income for this month.
• And one step further, if you sold something that you’ve had on the shelf awhile, and paid the supplier for it last month, your current month income statement shows an expense – cost of goods sold – that didn’t consume any cash this month. Your adjusted net income will put that cash back into the bank, so to speak, because you already paid for it earlier (and that payout would have shown up your prior month’s adjusted net income). Of course, if your customer didn’t pay for it at the time of sale, the selling price will come back out of adjusted net income until you get paid.

See, it’s not rocket science after all. Need help getting your adjusted net income closer to your accrual basis net income? Call us. We can help. Or you could just read the book.

We are Your CFO for Rent.